A Delaware Statutory Trust or DST are growing in popularity among real estate investors in the U.S. It’s safe to say that DST’s have rightfully earned this position given that they offer a number of potential advantages to investors.
However there are many Delaware Statutory Trust pros and cons. This article discusses a handful of the potential advantages that are available to investors using DSTs for their 1031 exchange. Please remember that Delaware Statutory Trusts also have a number of disadvantages that investors should consider as well. Before we explore the benefits offered by a DST let’s first examine what exactly is meant by a DST 1031 exchange.
What is a DST 1031 Exchange?
A DST is a provision or entity that allows investors to enjoy deferred capital gains taxes when they sell a real estate rental property. However, in order to realize this benefit, they must direct the proceedings from the sale of their property towards purchasing a fractional interest in professionally managed, high-quality institutional real estate. Later on, if the investor wants, they can also exchange the DST into a REIT but it may entail a lengthy process.
Used correctly, DSTs can indeed be an effective tool for building and preserving wealth as they help investors defer their capital gains tax from the sale of a real estate rental property. Therefore and quite understandably, utilizing Delaware Statutory Trusts in real estate planning can reap considerable rewards. Some examples of the types of real estate property that can qualify for a DST 1031 exchange include triple net (NNN) leased retail centers, apartment complexes, office property, and self-storage buildings.
Benefits Offered By a DST
A 1031 exchange into a DST has several merits:
Free yourself from the three Ts of active management
Tenants, toilets and trash. Many investors are attracted to Delaware Statutory Trusts because they offer the potential for a passive income stream. This feature is especially popular among those investors transitioning from an active real estate management role via a 1031 tax-deferred exchange. Active real estate management can be a time-consuming and tiring occupation which many property owners don’t want to continue into retirement. However, cashing out of a property held over a lifetime will usually incur a substantial capital gains tax hit that will erase much of the wealth that has been accumulated. Delaware Statutory Trusts allow an investor to utilize a 1031 exchange to acquire a professionally managed institutional grade asset, which provides a potential stream of income without the headaches of property management and asset management.
Access to long-term triple net leased (NNN) properties
One of the most significant Delaware Statutory Trust offerings is that it can offer investors access to triple net leased (NNN) properties that range from 5-20 years on the primary lease term, depending on the specific investment. This provides a potential long-term income stream without the hassle and risks of lease renegotiation. This is particularly relevant for investors who are moving to a Delaware Statutory Trust from a multifamily, apartment or single-family rental investment. Instead of dealing with multiple tenants renewing (or not renewing) their lease once a year, a Delaware Statutory Trust investor may potentially have 5-20 years of income already pre-arranged for. This both reduces the headaches of property management and provides a predictable and durable income stream. It is important to note that long-term leased properties, although attractive, can have problems too, such as tenants going out of business. It is important to review the tenant’s business model, credit rating, and future growth prospects to understand the level of risk one is assuming with a long-term leased property.
Potential for non-recourse debt vs recourse debt
Most debt on Delaware Statutory Trusts is non-recourse which greatly limits an investor’s liability to the lender. This helps to protect an investor’s other properties, investments, etc., should an investment fail. Especially for those investors switching to a Delaware Statutory Trust in retirement – non-recourse debt adds an extra layer of safety. Non-recourse debt is typically defined as a loan whereby the lender’s only remedy in case of a default is the subject property itself and not the investor’s other assets. Many investors that purchase commercial, multifamily and triple net leased Delaware Statutory Trust properties on their own are stuck with full or partial recourse loans from their lenders which increases overall risk substantially. With most DSTs, non-recourse debt is enjoyed by investors.
Potential for diversification into smaller dollar amounts
Delaware Statutory Trusts give investors access to institutional grade real estate for smaller dollar amounts. In contrast, higher quality triple net leased properties (which are often compared to Delaware Statutory Trusts) typically have a price floor around $1,500,000. This not only allows more potential investors access to Delaware Statutory Trusts, but also allows investors to spread risk across multiple assets instead of concentrating it in one Delaware Statutory Trust property.
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